In economics, the term commodity is used specifically for economic goods that have full or partial but substantial fungibility; that is, the market treats their instances as equivalent or nearly so with no regard to who produced them[1]. In simple terms a commodity is a basic good used in commerce that is interchangeable with other goods of the same type. Commodities are most often used as inputs in the production of other goods or services. The quality of a given commodity may differ slightly, but it is essentially uniform across producers[2].
The basic idea is that there is little differentiation between a commodity coming from one producer and the same commodity from another producer. A barrel of oil is basically the same product, regardless of the producer. By contrast, for electronics merchandise, the quality and features of a given product may be completely different depending on the producer.
A commodity is a basic good used as an input in the production of goods and services. That means companies use commodities in the manufacturing process to turn them into everyday goods. Commodities are found in the majority of goods that end up in the hands of consumers, including tires, tea, ground beef, orange juice, and clothing. The most common commodities include copper, crude oil, wheat, coffee beans, and gold. There is little difference, if any, among commodities. They are taken from their natural state and, if necessary, brought up to meet minimum marketplace standards. No value is added to the commodity, and all commodities of the same good sell at the same price regardless of the producer.
Commodities can be further broken down into two different categories: hard and soft commodities. Soft commodities are those that are grown and cannot be stored for extended periods. Examples include coffee, cocoa, orange juice, and sugar. Soft commodities futures are more volatile than others because of the unpredictable risks involved, including the weather. Hard commodities, on the other hand, are mined and extracted, such as oil, natural gas, and precious metals. All of these commodities are a major part of the futures market[3].
Most of the world’s widely traded commodities have well-established markets and are traded on exchanges primarily in the form of futures; contracts to buy or sell the commodity by a specified time in the future at a certain price. The settlement of a contract means the delivery of an actual asset or cash. Trading commodities has the potential for significant market volatility.
When they are traded on an exchange, commodities must also meet specified minimum standards, also known as a basis grade. The basis grade is the minimum accepted standard that a deliverable commodity must meet for use as the actual asset of a futures contract. This grading is also known as par grade or contract grade. Basis grade is vital for trading in futures and to maintain uniformity within the market. As the name implies, the basis grade establishes a baseline from which other variations of the same product or material compare. Products failing to meet this established basis grade, are unacceptable and have the risk of rejection. Since basis grade is the minimum tolerable accepted standard, ideally the exchanged commodity would exceed the criteria. Products of a higher quality which exceed the basis grade command a higher value and justify better exchange terms. Commodities such as oil and grains may vary drastically in quality. For example, the setting of the basis grade for a crude futures contracts is according to the specific levels of hydrogen and sulfur contained in the oil[4].
To summarize:
· A commodity is a basic good used in commerce that is interchangeable with other commodities of the same type.
· Commodities are most often used as inputs in the production of other goods or services.
· Investors and traders can buy and sell commodities directly in the spot (cash) market or via derivatives such as futures and options.
· Owning commodities in a broader portfolio is encouraged as a diversifier and a hedge against inflation.
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